Navigating Brazil’s Currency Volatility With USD Credit-imfastcenter

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2025-09-25

Navigating Brazil’s Currency Volatility With USD Credit

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Brazil’s fixed income market is one of the deepest in emerging markets, with an outstanding government debt of over BRL 8 trillion (roughly 75% of GDP) and a corporate bond market dominated by floating-rate instruments tied to the interbank deposit certificate (CDI).

Domestic market participants are accustomed to high nominal yields; local treasury bills linked to the Selic often offer double-digit returns, creating a strong home-market bias. However, attractive as these base rates may appear to some market participants, they are not a substitute for diversified credit exposure. For institutional allocators, USD-denominated corporate bonds can provide access to global issuers, industry sectors and credit premium not fully represented in Brazil.

The challenge, however, is that unhedged USD credit exposure tends to come with significant FX volatility—in many cases, BRL moves can overwhelm the underlying credit performance. This tension between the richness of local carry and the diversification of global markets raises a central question for asset allocators: How can Brazilian market participants tap global credit markets while managing excessive currency risk?

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Introducing the iBoxx BRL Hedged USD Credit Indices

To address this challenge, S&P Dow Jones Indices (S&P DJI) has introduced two new indices: the iBoxx USD Liquid Investment Grade BRL Hedge Carry Index (BRL) and the iBoxx USD Liquid High Yield BRL Hedge Carry Index (BRL).

Using a cash-bond-futures framework, the new indices seek to reduce currency volatility while preserving yield potential. To balance credit access with risk management, the iBoxx USD Liquid Investment Grade BRL Hedge Carry Index (BRL) has a 30% weight in the iBoxx $ Liquid Investment Grade Index (BRL) for core credit, has a 70% weight in cash earning the CETIP interbank rate to act as a volatility buffer and margin source and applies a -30% overlay in BRL futures via the S&P/B3 BRL-USD Mini Futures Index (BRL) ER to provide a structural hedge against currency risk.

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From a Brazilian point of view, these indices offer a way to measure USD credit while addressing FX risk. By embedding a structural hedge, they have historically tended to show smoother BRL-adjusted performance that could integrate more naturally into local strategies. At the same time, the high local carry has helped to enhance yield potential, all while reducing overall volatility.

From a global perspective, this is a rules-based index that can help translate international credit market exposures into Brazilian market terms, leveraging the full capability of the S&P/B3 and iBoxx Fixed Income index Series.

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Comparing the back-tested index level time series of the new iBoxx USD Liquid Investment Grade BRL Hedge Carry Index (BRL) with the iBoxx $ Liquid Investment Grade Index TR (BRL) shows that the new index often reduced volatility while maintaining competitive returns. There were also reduced drawdowns, where hedging mitigated the sharp FX-driven losses often seen in stress periods. A similar pattern was also observed in the iBoxx USD Liquid High Yield BRL Hedge Carry Index (BRL).

Exhibits 4 and 5 show that the iBoxx USD Liquid Investment Grade BRL Hedge Carry Index (BRL) saw volatility fall from 15.12% to 2.56% when compared to the benchmark, while the Sharpe ratio climbed from 0.75 to 3.61. For the iBoxx USD Liquid High Yield BRL Hedge Carry Index (BRL), volatility fell from 13.03% to 10.13%, while the Sharpe ratio improved modestly from 0.96 to 1.85, demonstrating an improvement on risk-adjusted return.

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Part of a Broader Story: S&P DJI’s Brazilian Fixed Income Suite

These launches build on a decade of collaboration in Brazil. The new BRL hedged indices show the breadth of our capabilities, from sovereign debt to corporate credit, from local instruments to global assets framed in Brazilian terms. It is built on a decade of collaboration with B3 and experience in the Brazilian market.

This is not just another index suite—it’s part of a comprehensive toolkit that can help to empower issuers, allocators and individual market participants to navigate Brazil’s evolving financial landscape.

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